Community Bank System, Inc. (NYSE:CBU) Q3 2023 Earnings Call Transcript

Community Bank System, Inc. (NYSE:CBU) Q3 2023 Earnings Call Transcript October 24, 2023

Community Bank System, Inc. beats earnings expectations. Reported EPS is $1.1, expectations were $0.88.

Operator: Good day, and welcome to the Community Bank’s 2023 Third Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Dimitar Karaivanov, Chief Operating Officer of Community Bank. Please go ahead.

Dimitar Karaivanov: Thank you, Marlese, and good morning everybody. Welcome to our conference call for the third quarter of 2023. As Mark noted in the press release, the company’s revenue performance was strong in the quarter. In fact, our revenue has been quite consistent over the past five quarters, regardless of all the macroeconomic and banking industry noise. This is a great example of the diversification of our business and the focus on lowering volatility for our investors. On the flip side, this quarter we had expense pressures that were above our expectations as well. Some of those are transient. Some of those are due to the general inflation pressures which should abate, and some are a function of the continuous investments in the company.

Over the past 24 months, we have invested in our organic capabilities across all of our businesses, and those investments run through the P&L. These organic investments are contributing to the growth in our outstandings in the banking business, the revenue performance in our benefits, insurance, and wealth businesses, and position us even better for the future. Our businesses are strong and healthy, supported by a strong balance sheet. As of the end of the quarter, our funding and liquidity are up compared to the beginning of the year. Our cycle to-date deposit beta is 13%, and our Tier 1 leverage capital is almost double the well-capitalized standard. That is in spite of the turmoils in the banking industry this year. With that, I will pass it on to Joe.

Joseph Sutaris: Thank you, Dimitar, and good morning everyone. As Dimitar noted, the company’s earnings results were down a bit in the third quarter. Fully diluted GAAP earnings per share were $0.82 in the quarter, which were $0.08 lower than the prior year’s third quarter and $0.07 lower than the linked second quarter results. Fully diluted operating earnings per share and non-GAAP measures defined in the press release were also $0.82 in the quarter, $0.08 per share lower than the prior year’s third quarter, and $0.09 per share lower than the linked second quarter results. The $0.08 decrease in operating earnings per share on a year-over-year basis were primarily driven by higher operating expenses. The $0.09 decrease in operating earnings per share on a linked quarter basis was driven by a decrease in net interest income and increases in the provision for credit losses and operating expenses, offset in part by an increase in non-interest revenues and a decrease in income taxes.

Reflective of our diversified revenue business model, the company’s total revenues in the third quarter of $175.4 million were generally consistent with the prior year’s third quarter total revenues of $175.6 million and the linked second quarter total revenues of $175.3 million. These results were driven by decreases in net interest income between the comparable periods due to higher funding costs, but were largely offset by increases in non-interest revenues. The company recorded net interest income of $107.8 million in the third quarter of 2023. This was down $1.5 million or 1.4% on a linked quarter basis and $2.6 million or 2.4% on a year-over-year basis. The third quarter result was consistent with our expectations of a sideways outcome for a few quarters as funding costs increases outpaced loan portfolio-related rate and volume improvements.

The company’s total cost of funds in the third quarter of 2023 was 88 basis points as compared to 67 basis points in the linked second quarter. The 21 basis point increase in funding costs in the quarter outpaced a 12 basis point increase in earning asset yields resulting in an 8 basis point decrease in the company’s fully taxed equivalent net interest margin from 3.18% in the second quarter to 3.10% in the third quarter. The year-over-year increase in non-interest revenues totaling $2.3 million or 3.6% was driven by a $2.1 million or 7.6% increase in employee benefit services revenues, a $0.8 million or 6.9% increase in insurance services revenues, and a $0.4 million or a 5.8% increase in wealth management services revenues, offset in part by a $1 million or 5.3% decrease in banking service revenues.

The increase in employee benefit services revenues was driven by conversion of new business and a significant year-over-year increase in total participants under administration, along with a modest increase for market appreciation. The increase in insurance services revenues are reflective of a strong premium market, organic expansion along with acquired growth between the periods. The increase in wealth management services revenues are reflective of a slightly more favorable investment market conditions, which drove an increase in assets under management. The decrease in banking non-interest revenues are reflective of the company’s implementation of certain deposit fee changes, including the elimination of non-sufficient and unavailable funds fees on personal accounts late in the fourth quarter of 2022.

Reflective of an increase in loans outstanding in the stable economic forecast, the company recorded a provision for credit losses of $2.9 million during the third quarter. Comparatively, the company recorded a $5.1 million provision for credit losses in the third quarter of the prior year and $0.8 million in the linked second quarter of 2023. The company recorded $116.5 million in total operating expenses in the third quarter of 2023 compared to $108.2 million of total operating expenses in the prior year’s third quarter. The $8.3 million, 7.7% increase between the periods was mainly driven by higher compensation employee benefits expense, data processing communication expenses, business development and marketing and other expenses. The $4.5 million, 6.8% increase in salaries and employee benefit expense was primarily driven by merit and market related increases in employee wages, higher employee medical expenses and certain executive retirement expenses.

The $1.3 million, 9.1% increase in data processing and communication expenses reflect the company’s continued investment in customer facing and back office digital technologies. Business development and marketing expenses increased $1 million or 28% due to the company’s investment in digital initiatives and the higher levels of targeted advertisements and tend to generate deposit inflows. Other expenses were up $1.5 million or 23.1%, primarily due to increase in insurance expenses and non-service related components of net periodic pension credit. Total operating expenses were up $3.5 million or 3.1% on a linked quarter basis, largely driven by a $2.7 million or 3.9% increase in salaries and employee benefit expenses and a $1.2 million or 8.3% increase in data processing and communication expenses.

The effective tax rate for the third quarter of 2023 was 21.2%, down from 22% in the third quarter of 2022 and 21.4% in the linked second quarter. The company’s total assets were $15.39 billion at September 30, 2023, representing a $208.2 million or 1.3% decrease from one year prior and a $278.3 million or 1.8% increase from the end of the second quarter of 2023. Ending loans increased $279.3 million or 3% during the quarter and $906.5 million or 10.6% over the prior year. The increase in loans outstanding in the third quarter was driven by an $81.2 million or 2.1% increase in the business lending portfolio and $198.1 million or 3.7% increase in the company’s consumer loan portfolios. The increase in ending loans year-over-year was driven by organic loan growth in the company’s business lending portfolio totaling $420.5 million or 12% and growth in all four consumer loan portfolios totaling $486 million or 9.6%.

The company’s ending total deposits were up $159 million or 1.2% from the end of the second quarter. Interest bearing deposits increased $233.6 million or 2.6% during the quarter, while non-interest bearing deposits decreased $74.6 million or 1.9%. On a year-to-date basis, ending total deposits were up $18.5 million or 0.1%. The company’s deposit base is well diversified across customer segments comprised of approximately 61% consumer balances, 26% business balances, and 13% municipal balances, and broadly dispersed with an average consumer deposit account balance of approximately $12,000 and average business deposit relationship of approximately $60,000. The company’s cycle-to-date deposit beta is 13%, reflective of a high proportion of checking and savings accounts, which represent 70% of total deposits and a composition and stability of the customer base.

The weighted average age of the company’s non-maturity deposit accounts is approximately 15 years and the company does not currently carry any brokered or wholesale deposits on its balance sheet. The company’s cycle-to-date interest bearing deposits beta is 18% and the total funding beta is 15%. During the quarter, the company secured $300 million in term borrowings at the Federal Home Loan Bank of New York at a weighted average cost of 4.69% to fund continued loan growth. The company’s liquidity position remains strong, readily available sources of liquidity, including cash and cash equivalents, funding availability at the Federal Reserve Bank’s discount window, unused borrowing capacity at the Federal Home Loan Bank of New York, and unpledged investment securities totaled $4.81 billion at the end of the third quarter, which is up from $4.23 billion at the end of the second quarter.

During the third quarter, the company pledged additional loan growth collateral at the Federal Reserve Bank to further enhance its barring capacity. These sources of immediately available liquidity represent over 200% of the company’s estimated uninsured deposits, net of collateralized and intercompany deposits. The company’s loan-to-deposit ratio at the end of the third quarter was 72.5%, providing future opportunity to migrate lower-yielding investment security balances into higher-yielding loans. At September 30, 2023, all the companies of the bank’s regulatory capital ratio significantly exceeded well-capitalized standards. More specifically, the company’s Tier 1 leverage ratio was 9.44% at the end of the third quarter, which substantially exceeded the regulatory well-capitalized standard of 5%.

The company’s net tangible equity and net tangible assets ratio or non-GAAP measure was 4.81% at the end of the third quarter, compared to 5.34% at the end of the second quarter and 4.08% one year prior. During the quarter, the third quarter, the company repurchased 100,000 shares of its common stock at an average price of $51 per share, pursuant to its board-approved 2023 stock repurchase program. At June 30, 2023, the company’s allowance for credit losses totaled $64.9 million or 69 basis points of total loans outstanding. This compares to $63.3 million or 69 basis points of total loans outstanding at the end of the second quarter of 2023, and $60.4 million or 71 basis points of total loans outstanding at September 30, 2022. During the third quarter, the company recorded net charge-offs of $1.2 million or 5 basis points of average loans annualized.

Annualized net charge-offs on a year-to-date basis are also 5 basis points. At September 30, 2023, non-performing loans totaled $36.9 million or 39 basis points of total loans outstanding. This is up from 36 basis points at the end of the second quarter and 38 basis points one year prior. Loans 30 to 89 days delinquent when we’re 51 basis points of total loans outstanding at September 30, 2023, up from 47 basis points at the end of the second quarter of 2023, and up from 33 basis points one year prior. Overall, the company’s asset quality remains strong and stable in the quarter. We believe the company’s strong liquidity profile, regulatory capital reserves, stable core deposit base, historically strong asset quality, and revenue profile provide a solid foundation for future opportunities and growth.

Looking forward, we are encouraged by the momentum in our business and prospects for continued organic loan growth. We believe funding cost pressures are abating, providing the company an opportunity to increase net interest income in the fourth quarter. In addition, new business opportunities in the company’s financial services businesses remain strong. As noted in our press release, the company has taken actions to optimize the customer service staffing levels in its retail business, which are expected to contain branch-related operating expenses for the next few quarters. Estimated severance and related expenses of $1 million to $1.5 million will be incurred and reflected in the fourth quarter results. Thank you. Now I’ll turn it back to Marlese to open the line for questions.

Oh, excuse me. I will turn it over to Mark to make a few comments. My apologies.

Mark Tryniski: Thank you, Joe. Good morning, everyone, and thanks for joining the call today. Given my impending retirement in a couple of months, I won’t be commenting on the quarter, but I did want to make a couple of brief comments before we answer questions. First, to our investors, thank you for your trust and confidence in us and our company over so many years. All that we do is done through the lens of shareholder value with the objective of providing above-average returns with below-average risk, and that will continue to be our primary operating priority. To our analysts, thank you for your engagement, effort and understanding of our company and always doing your best with imperfect information. I would also like to thank our Board of Directors for their trust and confidence in me over the past 17 years.

It’s been a privilege and the joy of my professional life to lead this company and work with such an engaged, caring, and shareholder-focused board. Finally, to our employees, thank you for all you have done and will continue to do to make this a great company and for your efforts, pride and passion in serving our customers, our communities, our shareholders and each other. You are truly the lifeblood of this organization. Community Bank System is incredibly well-positioned for the future. We have four tremendous businesses and the best of leadership and operating teams we have ever had. I have absolute confidence in Dimitar and am very much looking forward to watching the continued progress and success of the company under his capable leadership.

Thank you, everyone, and best wishes to all of you for personal and professional prosperity.

Joseph Sutaris: We will now turn over to Marlese for questions.

Operator: Thank you very much. And we will start the question-and-answer session. [Operator Instructions]. Our first question comes from Nick Cucharale from The Hovde Group. Nick, please go ahead.

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Q&A Session

Nick Cucharale : Good morning, everyone, and best wishes to you Mark.

Mark Tryniski : Thanks Nick.

Dimitar Karaivanov: Good morning, Nick.

Joseph Sutaris: Good morning, Nick.

Nick Cucharale : Good morning. So you touched on it in the release and in your remarks, but can you provide more detail then on the de novo initiatives? What markets are you targeting? And at this point, do you have a sense for how many locations you plan to open as you reoptimize the branch network?

Dimitar Karaivanov: Sure, Nick. It’s Dimitar. So we’re embarking on a continued organic growth in all of our larger markets. So we have entered them commercially and we’ve been in them to some degree on the retail side for a number of years now. But on the tail of our success on the commercial business, we’re going to be expanding on the retail side as well, kind of in earnest, in Buffalo, Rochester, Syracuse, Lehigh Valley in PA, Southern New Hampshire, probably a little bit in the Capital District as well. So those are kind of the areas we’re looking at. It varies by market in terms of how many locations and what we’re going to be opening. But right now, I think in the next 18 months or so, we can pencil in about 12 to 15 locations across those markets.

It might be a couple more, depending if we find the right locations. At the same time, as Joe noted, we are reconfiguring our existing network and staffing levels. And the purpose of all of this is for this initiative to be self-funding in many ways and just provide us with a much better, much more productive, I would say, go-forward retail presence.

Nick Cucharale : That’s great, color. Maybe just a related follow-up. Can you help us think about the overall expense run rate going forward and how much of this quarter’s elevation is likely to persist?

Joseph Sutaris: Yeah. So with respect to expenses, as I think Dimitar mentioned, there are some which we anticipate as being sort of transient, some of which are really reflective of our investment in the organic growth machine over the last couple of years, and some of which is really related to, I’ll call it wage-related inflationary pressures that we had to endure, if you will, in 2022. So our full-year expectation for ‘23 versus ‘22 is, as I think we’ve said earlier, somewhere between 5% and 9%. It looks like it’s trending to something closer to 8% on a full-year run rate basis. But the expectation is that we would settle back into something kind of in the mid-single-digit run rate increase year-over-year on a full-year basis.

There’s always a bit of volatility quarter-to-quarter. Sometimes it’s just timing, if you will, in a particular quarter. And obviously this quarter was a little bit harder hit with some transient expenses than we’ve had in the past. But our expectation I think for 2024 is kind of mid-single digits on operating expense increases on a full-year basis.

Nick Cucharale : That’s very helpful. And then lastly for me, just given the strong loan growth and an increase in borrowings this quarter, can you share with us your thought process and appetite for executing another securities restructuring?

Dimitar Karaivanov: I think, Nick, at this point given where rates are and what we have left in the portfolio, the math is pretty challenging. We’re looking at that in the sense of, is it a positive net present value transaction? So, if we’re accelerating cash flows and at the end of the day we’re all better off by getting our money sooner than later, we will consider it, which is what we did earlier this year. As a reminder, we sold roughly three-year tenured securities and we’re getting the cash flows back in two years. So we’ve got essentially a year worth of positive value on that transaction. That’s when the tenure was in the threes. And I think given where the tenure is today and kind of the front end of the curve as well, those numbers just don’t pencil out.

Nick Cucharale : Thank you for taking my questions.

Operator: And our next question is coming from Steve Moss from Raymond James. Steve, please proceed.

Steve Moss: Good morning.

Dimitar Karaivanov: Good morning, Steve.

Joseph Sutaris: Good morning, Steve.

Steve Moss: And Mark, congratulations on your retirement and best wishes. I just wanted to follow-up on the loan side of things here. Very strong quarter for growth. Could we see this pace continue for another quarter or could we see some moderation here just given the extra moving rates, even in the last couple of weeks here?

Joseph Sutaris: I think, Steve, if you look and you break it down by portfolio, the commercial pipeline is still strong, but not as strong as it was at the end of the second quarter. So you’ll probably see a bit of a pullback there. Mortgage is going to be seasonally a little bit weaker as well in the fourth quarter. And I think the same applies for auto in the sense that right now that flow and kind of what we’re charging there is a little bit less. So I think it’s still going to be a very strong quarter in terms of growth, but I don’t think it’s going to be close to this past quarter, which was close to a record for us in terms of total loan growth.

Steve Moss: Right. And curious Dimitar, what rates are you guys seeing for loan yields these days that you’re putting on the books?

Dimitar Karaivanov: I think the blended trade for the third quarter was $720.